BENCHMARK ELECTRONICS, INC. The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto in Item 8 of this Report. You should also bear in mind the Risk Factors set forth in Item 1A, any of which could materially and adversely affect the Company's business, operating results, financial condition and the actual results of the matters addressed by the forward-looking statements contained in the following discussion.
In
Ransomware Incident
During the fourth quarter ended
The Company restored connectivity and resumed operations quickly following the ransomware incident. However, fourth quarter 2019 operations were adversely affected by the inefficiencies caused by taking the network offline for a period of time. As a result, the Company's fourth quarter 2019 revenue was also adversely affected as the Company was unable to fulfill a portion of customer demand during the quarter.
We do have insurance coverage, including cyber insurance, and are working diligently with our insurance carriers on claims to recover costs incurred. We expect that the insurance recovery process will be ongoing throughout 2020.
In 2019, ransomware incident related costs incurred totaled
We expect to incur additional costs related to the ransomware event in 2020, but these are not expected to be significant. Further insurance recoveries will be recorded when considered probable for recovery.
2019 OVERVIEW
Sales for 2019 were
·Industrials decreased by 8%,
·A&D increased by 6%,
·Medical increased by 14%,
·Semi-cap decreased by 22%,
·Computing decreased by 38%, and
·Telecommunications decreased by 12%.
The overall revenue decrease was due primarily to our planned exit of a legacy Computing contract which was completed in 2019 (as discussed below), in addition to the decline in the overall semi-cap market, reduced revenues
33
--------------------------------------------------------------------------------
from other Computing and Telecommunications customers and the impact of the ransomware incident (as discussed below).
Our sales depend on the success of our customers, some of which operate in businesses associated with rapid technological change and consequent product obsolescence. Developments adverse to our major customers or their products, or the failure of a major customer to pay for components or services, can adversely affect us. A substantial percentage of our sales are made to a small number of customers, and the loss of a major customer, if not replaced, would adversely affect us. Sales to our ten largest customers represented 38% and 44% of our sales in 2019 and 2018, respectively. In 2019, there was no single customer with sales over 10% of our sales. In 2018, sales to International Business Machines Corporation (IBM) represented 13% of our sales.
As part of our ongoing process to review contracts that are marginal and dilutive to our gross margin, we made the decision to not renew the contract with a large Computing customer that was to expire at the end of 2019. During the second quarter of 2019, we completed the final build out of this legacy contract and in the third quarter had an immaterial amount of revenue from this contract as the transition was completed.
During 2019, we incurred an
We experience fluctuations in gross profit from period to period. Different programs contribute different gross profits depending on the type of services involved, location of production, size of the program, complexity of the product and level of material costs associated with the various products. Moreover, new programs can contribute relatively less to our gross profit in their early stages when manufacturing volumes are usually lower, resulting in inefficiencies and unabsorbed manufacturing overhead costs. In addition, a number of our new and higher-volume programs remain subject to competitive constraints that can exert downward pressure on our margins. During periods of low production volume, we generally have idle capacity and reduced gross profit. Gross profit can also be impacted by other situations, such as the ransomware incident experienced in 2019.
We have undertaken initiatives to restructure our business operations with the
intention of improving utilization and reducing costs. During 2019, we
recognized
During 2019, we incurred
RESULTS OF OPERATIONS
The following table presents the percentage relationship that certain items in our Consolidated Statements of Income bear to sales for the periods indicated. The financial information and the discussion below should be read in conjunction with the Consolidated Financial Statements and Notes thereto in Item 8 of this Report.
34
--------------------------------------------------------------------------------
Year ended December 31,
2019 2018 2017
Sales 100.0 % 100.0 % 100.0 %
Cost of sales 91.2 91.4 90.8
Gross profit 8.8 8.6 9.2Selling, general and administrative expenses 6.2 5.6 5.3 Amortization of intangible assets
0.4 0.4 0.4
Restructuring charges and other costs 0.6 0.4 0.4
Ransomware related incident costs, net 0.3 - -
Income from operations 1.3 2.3 3.1
Other expense, net (0.1) (0.1) (0.2)
Income before income taxes 1.2 2.2 2.9
Income tax expense 0.2 1.3 4.2
Net income (loss) 1.0 % 0.9 % (1.3) %
2019 Compared With 2018
Sales
As noted above, sales decreased 12% in 2019. The percentages of our sales by
sector were as follows:
2019 2018
Higher-Value Markets
Industrials 20 % 19 %
A&D 19 16
Medical 20 15
Semi-Cap 12 14
71 64
Traditional Markets
Computing 16 23
Telecommunications 13 13
29 36
Total 100 % 100 %
Industrials. 2019 sales decreased 8% to
Aerospace and Defense. 2019 sales increased 6% to
Medical. 2019 sales increased 14% to
Semiconductor Capital Equipment. 2019 sales decreased 22% to
Computing. 2019 sales decreased 38% to
35
--------------------------------------------------------------------------------
Telecommunications. 2019 sales decreased 12% to
Our international operations are subject to the risks of doing business abroad. See Item 1A for factors pertaining to international sales, fluctuations in foreign currency exchange rates and a discussion of potential adverse effects in operating results associated with the risks of doing business abroad. During 2019 and 2018, 47% and 45%, respectively, of our sales were from international operations.
Gross Profit
Gross profit decreased 9.2% to
Selling, General and Administrative Expenses
SG&A decreased to
Amortization of Intangible Assets
Amortization of intangible assets was
Restructuring Charges and Other Costs
During 2019, we recognized
Ransomware Incident Related Costs, Net
During 2019, we incurred
Interest Expense
Interest expense decreased to
36
--------------------------------------------------------------------------------
Interest Income
Interest income decreased to
Income Tax Expense.
Income tax expense of
We have been granted certain tax incentives, including tax holidays, for our
subsidiaries in
Net Income
We reported a net income of
LIQUIDITY AND CAPITAL RESOURCES
We have historically financed our organic growth and operations through funds
generated from operations and occasional borrowings under our revolving credit
facility. Cash and cash equivalents and restricted cash totaled
Cash provided by operating activities was
We purchase components only after customer orders or forecasts are received, which mitigates, but does not eliminate, the risk of loss on inventories. Supplies of electronic components and other materials used in operations are subject to industry-wide shortages. In certain instances, suppliers may allocate available quantities to us. If shortages of these components and other material supplies used in operations occur, vendors may not ship the quantities we need for production, and we may be forced to delay shipments, which can increase backorders and impact cash flows.
Cash used in investing activities was
37
--------------------------------------------------------------------------------
and equipment in the
Cash used in financing activities was
Under the terms of our
The Credit Agreement contains certain financial covenants as to interest
coverage and debt leverage, and certain customary affirmative and negative
covenants, including restrictions on our ability to incur additional debt and
liens, pay dividends, repurchase shares, sell assets and merge or consolidate
with other persons. Amounts due under the Credit Agreement could be accelerated
upon specified events of default, including a failure to pay amounts due, breach
of a covenant, material inaccuracy of a representation, or occurrence of
bankruptcy or insolvency, subject, in some cases, to cure periods. As of
Our operations, and the operations of businesses we acquire, are subject to certain foreign, federal, state and local regulatory requirements relating to environmental, waste management, health and safety matters. We believe we operate in substantial compliance with all applicable requirements and we seek to ensure that newly acquired businesses comply or will comply substantially with applicable requirements. To date, the costs of compliance and workplace and environmental remediation have not been material to us. However, material costs and liabilities may arise from these requirements or from new, modified or more stringent requirements in the future. In addition, our past, current and future operations, and the operations of businesses we have or may acquire, may give rise to claims of exposure by employees or the public, or to other claims or liabilities relating to environmental, waste management or health and safety concerns.
As of
On
The Company began declaring and paying quarterly dividends during the first
quarter of 2018. During 2019 and 2018, cash dividends paid totaled
38
--------------------------------------------------------------------------------
common share. The Board of Directors currently intends to continue paying quarterly dividends. However, the Company's future dividend policy is subject to the Company's compliance with applicable law, and depending on, among other things, the Company's results of operations, financial condition, level of indebtedness, capital requirements, contractual restrictions, restrictions in the Company's debt agreements, and other factors that the Board of Directors may deem relevant. Dividend payments are not mandatory or guaranteed; there can be no assurance that the Company will continue to pay a dividend in the future.
Management believes that our existing cash balances and funds generated from operations will be sufficient to permit us to meet our liquidity requirements over the next 12 months. Management further believes that our ongoing cash flows from operations and any borrowings we may incur under our revolving credit facility will enable us to meet operating cash requirements in future years. If we consummated significant acquisitions in the future, our capital needs would increase and could possibly result in our need to increase available borrowings under our Credit Agreement or access public or private debt and equity markets. There can be no assurance, however, that we would be successful in raising additional debt or equity on acceptable terms.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with
Allowance for Doubtful Accounts
Our accounts receivable balance is recorded net of allowances for amounts not expected to be collected from our customers. Because our accounts receivable are typically unsecured, we periodically evaluate their collectability based on a combination of factors, including a particular customer's ability to pay as well as the age of the receivables. To evaluate a specific customer's ability to pay, we analyze financial statements, payment history and various information or disclosures by the customer or other publicly available information. In cases where the evidence suggests a customer may not be able to satisfy its obligation to us, we establish a specific allowance in an amount we determine appropriate for the perceived risk. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
Inventory Obsolescence
We purchase inventory based on forecasted demand and record inventory at the lower of cost or net realizable value. We write down inventory for estimated obsolescence, as necessary, in an amount equal to the difference between the cost of inventory and estimated market value based on assumptions of future demands and market conditions. We evaluate our inventory on a quarterly basis based on current and forecasted usage and the latest forecasts of product demand and production requirements from our customers. Customers frequently make changes to their forecasts, which requires us to make changes to our inventory purchases, commitments, and production scheduling and may require us to cancel open purchase commitments with our vendors. This process may lead to on-hand inventory quantities and on-order purchase commitments that exceed our customers' revised needs, or parts that become obsolete before use in production. We write down excess and obsolete inventory when we determine that our
39
--------------------------------------------------------------------------------
customers are not responsible for it, or if we believe our customers will be unable to fulfill their obligation to ultimately purchase it. If actual market conditions are less favorable than those we projected, additional inventory write-downs may be required.
Revenue Recognition
Our revenue is recognized when a contract exists and when, or as, we satisfy a performance obligation by transferring control of a product or service to the customer. A contract exists when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. For the Company, the arrangement with the customer is generally documented through a master agreement which outlines the general terms and conditions of the arrangement and a specific purchase commitment from the customer.
Our performance obligations are satisfied over time as work progresses or at a point in time. The determination of how our performance obligations are satisfied requires judgment and is assessed on a contract by contract basis. Under the majority of our contracts, our performance obligations are satisfied over time as work progresses since the customer controls all of the work-in-progress as products are being built. For these contracts, the selection of the method to measure progress towards completion requires judgment and is based on the nature of the products or services to be provided. We use a cost-based input measurement of progress because is best represents the transfer of assets to the customer. For our other contracts, revenue is recognized upon transfer of control of the product or service, which is generally upon shipment or delivery pending on the terms of the underlying contract. Revenue from design, development and engineering services is generally recognized over time as the services are performed.
Generally, there are no subjective customer acceptance requirements or further obligations related to goods of services provided. Our contracts with customer do not allow for a general right of return.
Income Taxes
We estimate our income tax provision in each of the jurisdictions where we
operate, including estimating exposures related to uncertain tax positions. We
must also make judgments regarding the ability to realize our deferred tax
assets. We record a valuation allowance to reduce our deferred tax assets to the
amount that we believe is more likely than not to be realized. Our valuation
allowance as of
Differences in our future operating results as compared to the estimates
utilized in the determination of the valuation allowances could result in
adjustments in valuation allowances in future periods. For example, a
significant increase in our operations in
On
40
--------------------------------------------------------------------------------
We are subject to examination by tax authorities for different periods in
various
Impairment of Long-Lived Assets and
Long-lived assets, such as property, plant, and equipment and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized by the amount that the carrying amount of the asset exceeds the fair value of the asset.
Based on our qualitative assessments of goodwill as of
Changes in economic and operating conditions that occur after the annual impairment analysis or an interim impairment analysis, and that impact these assumptions, may result in a future goodwill impairment charge.
Stock-Based Compensation
We recognize stock-based compensation expense in our consolidated statements of income. For performance-based restricted stock unit awards, compensation expense is based on the probability that the performance goals will be achieved, which is monitored by management throughout the measurement period. If it becomes probable, based on our expectation of performance during that measurement period, that more or less than the previous estimate of the awarded shares will vest, an adjustment to stock-based compensation expense is recognized as a change in accounting estimate. If actual results or future changes in estimates differ significantly from our current estimates, stock-based compensation could increase or decrease. See Note 1(l) to the Consolidated Financial Statements in Item 8 of this Report.
Recently Enacted Accounting Principles
See Note 1(q) to the Consolidated Financial Statements in Item 8 of this Report for a discussion of recently enacted accounting principles.
41
--------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS
We have certain contractual obligations that extend beyond 2020 under lease
obligations and debt arrangements. Non-cancelable purchase commitments do not
typically extend beyond the normal lead-time of several weeks. Purchase orders
beyond this time frame are typically cancelable. We do not use off-balance sheet
financing techniques other than traditional operating leases, and we have not
guaranteed the obligations of any entity that is not one of our wholly owned
subsidiaries. The total contractual cash obligations in existence at
Payments due by period
Less than 1-3 3-5 More than
(in thousands) Total 1 year years years 5 years
Operating lease obligations $ 101,471 $ 14,552 $ 22,567 $ 18,336 $ 46,016
Finance lease obligations 5,915 1,781 3,669 465 -
Long-term debt obligations 144,375 7,500 15,000 121,875 -
Deemed repatriation tax (1) 57,506 6,439 12,878 28,170 10,019
Total obligations $ 309,267 $ 30,272 $ 54,114 $ 168,846 $ 56,035 (1)
OFF-BALANCE SHEET ARRANGEMENTS
As of
© Edgar Online, source
